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Middle East Turmoil: A Rollercoaster Ride for Oil

Oil is gradually approaching its ultimate resistance level, the $100 mark, the longtime benchmark which separates oil prices from hysteria. The black gold, which had been trading at $85 per barrel (WTI contracts) only in December, ended last week trading at $98 per barrel, representing a $13 or 15% rise in less than two months. Yet, this latest rise in oil prices was balanced and divided over several weeks and therefore did not raise any alarm bells in investors’ minds (which seem to be preoccupied with equities). But as latest developments suggest, this balanced gain in oil prices could soon be replaced by a volatile rollercoaster ride into highs not seen for some time, crossing deep into the $100-150 territory.

Although, it is easy to attribute oil price fluctuations to growth expectations and stimulus from central banks, that is not the case now or, at least, not the major force, particularly when compared to the geopolitical and national tensions in the Middle East. These can cause the oil-rich region and energy-supply hub to drift into chaos; thereby, threatening oil’s supply chain and increasing bets on yet another buying spree of the Black Gold, as anxiety in the energy market can quickly turn into hysteria -- as it has many times in the past. But before we dive into inventories levels and technical analysis on oil, a little background on the brewing tensions in the Middle East might be in order.

In the past few months, gradually but confidently, flames in the Middle East have escalated and with growing intensity, one must add. Tensions in the Middle East, in fact, have been brewing for the past two years as the region alongside North Africa experienced an unprecedented political shakeup, affectionately called the Arab Spring by journalists. It seems the global community, international leaders and investors were all hoping and perhaps dreaming the “old” order in the region wiould be replaced by a new order but, as events unfolded, reality morphed into their worst nightmares.

Egypt seems to be deteriorating into chaos, as the newly elected Muslim Brotherhood loses grip on its country and institutions. As if this were not enough, tensions reached a climax in the region last week when Israel allegedly launched an aerial attack on one of Syria’s chemical weapons stockpiles. As intelligence sources suggested (according to foreign press), the Assad regime is passing out weapons of mass destruction to extremist terrorist groups. This latest round of escalation, according to Roula Khalaf from the Financial Times, signals a danger of a new kind. On the one hand, Israel has shown it is ready to cross redlines and attack Syrian military compounds near Damascus -- a clear provocation on Syrian sovereignty. On the other hand, the crumbling regime of Assad has crossed its own redline by passing its mass destruction weapons to terrorist groups. For years, the region’s conflicts have been limited to local events, held in place by a delicate balance of powers. However, the past few weeks indicate those powers are increasingly ready to cross new lines and risk an overall conflict in the Middle East. While this bipolar tension in the region escalates , the region’s stability crumbles as many Arab nations are on the verge of dissolving into small rival tribes with no political gravity and nothing to lose.

Back To Oil

So how are those tensions connected to oil? The region is one of the most prominent sources of oil. Saudi Arabia is one of the world’s top 3 oil producers and Iran is among the top 5 -- both countries are at risk in this conflict. Then, there is the real wild card, the Hormus Straits, one of the key passages for oil tankers in the region with 17M of Oil barrels passing daily -- enough to satisfy China’s demand 3 times and more, according to the Financial Times. With Iran constantly threatening to block the Straits, which are right at its back yard, it is easy to imagine what kind of an oil supply shock the energy market might absorb if tensions spiral out of control and Iran realizes its threats one day. The willingness of each of the parties in the conflict to raise the stakes paves a one-way road toward showdown and ultimately an oil supply shock, at least in the eyes of the writer of this very article.

Inventories Emphasis Middle East Importance

If to examine the EIA report which monitors buildup of inventories on the different PADDs around the U.S. ,the outlook for Oil is rather stable. Inventories have largely topped out around 380 Million Barrels in mid of 2012 before sliding lower and stabilizing between 360-380M barrels as U.S. growth rates remained moderate.

One may conclude from the stability in inventory levels since August 2012 and Oil price fluctuations for the same period that it is clear that oil prices have been relatively in range, moving in tandem with EIA inventory count. This suggests that if U.S. growth remains at the same pace, it will not be sufficient to press inventories lower and push oil prices to $100 and beyond. Since U.S. growth is indeed expected to remain moderate, the Middle East will remain the wild card for any Oil rally. Therefore, any sign of fading tensions in the region could quickly shift investors to shift their attention on oil inventories, which, as fundamentals suggest, is not enough to push prices higher then $100. This literally explains the volatile ride expected by oil bulls that foresee $120 as the next target, as every pause in Middle East tensions quickly undermining Oil’s rally and leading to a correction.

Let’s Get Technical

When examining Oil’s technical picture it is soon realized Oil prices are locked within a triangle with rising support levels and also lower highs, and as the range narrows potential momentum for a break to either side grows. If to consider the path of Middle East tensions then one can assume the upper 100$ resistance could be the one to break rather than the lower 87$ support , with the 120$ as the next target for Oil, at least to my opinion, but with the shaky Middle East as the engine of this rally , don’t expect a smooth ride.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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